Masonite International Corporation (NYSE:DOOR) Q2 2022 Earnings Conference Call August 9, 2022 9:00 AM ET
Company Participants
Richard Leland – VP, Finance and Treasurer
Howard Heckes – President and CEO
Russell Tiejema – EVP and CFO
Chris Ball – President, Global Residential
Conference Call Participants
Mike Rehaut – JPMorgan
Mike Dahl – RBC Capital Markets
Josh Chan – Baird
Noah Merkousko – Stephens
Steven Ramsey – Thompson Research Group
Jay McCanless – Wedbush Securities
Operator
Welcome to Masonite’s Second Quarter 2022 Earnings Conference Call. During the presentation all participants will be in a listen-only mode. After management’s prepared remarks, investors are invited to participate in a question-and-answer session. Please note this conference call is being recorded.
I would now like to turn the conference over to Rich Leland, Vice President, Finance and Treasurer. Thank you. You may begin.
Richard Leland
Thank you and good morning, everyone. We appreciate you joining us for today’s call. With me here this morning are Howard Heckes, President and Chief Executive Officer; and Russ Tiejema, Executive Vice President and Chief Financial Officer. Also joining us today for Q&A is Chris Ball, our President of Global Residential.
We issued a press release and earnings presentation yesterday, reporting our second quarter 2022 financial results. These documents are available on our website at masonite.com. Before we begin, let me remind you that this call will include forward-looking statements. Each forward-looking statements contained in this call is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statement.
Additional information regarding these factors appears in the section entitled, Forward-Looking Statements in the press release we issued yesterday. More information about risks can be found under the heading Risk Factors in Masonite’s most recently filed Annual Report on Form 10-K and our subsequent Form 10-Qs, which are available at sec.gov and at masonite.com.
The forward-looking statements in this call speak only as of today and we undertake no obligation to update or revise any of these statements. Our earnings release and today’s discussion includes certain non-GAAP financial measures. Please refer to the reconciliations which are in the press release and the appendix of the earnings presentation.
Our agenda for today’s call includes a business overview from Howard, followed by a review of the second quarter results from Russ. And then Howard will provide some closing remarks and we will begin the question-and-answer session.
And with that, let me turn the call to Howard.
Howard Heckes
Thanks, Rich. Good morning and welcome everyone.
I’m pleased to report that Masonite continued to deliver significant year-over-year growth in the second quarter as expected and as noted on Slide 4. Net sales for the quarter were up 15%, while adjusted EBITDA increased 7%. Adjusted earnings per share for the period grew 16%, driven by both positive earnings and a reduction in shares outstanding.
The accelerated share repurchase program we announced in March of this year was completed in the second quarter, resulting in retirement of roughly 320,000 shares on top of the approximately 848,000 shares that had been retired as part of the program in Q1.
In total, this program reduced shares outstanding by approximately 5%. A key part of our operating philosophy is to maintain price/cost favorability. Once again this quarter, we took appropriate actions, given material and logistics inflation that continues to run higher than anticipated this year.
With respect to business operations, our North American Residential segment once again delivered excellent results by servicing steady demand and realizing 3% year-over-year volume growth in the quarter. In Europe, economic and geopolitical issues continued to weigh on consumer confidence and negatively impacted market demand.
In this difficult environment, our team has done a good job of navigating the challenges and continues to take actions to manage costs. Lastly, the Architectural segment delivered sequential improvement in profitability as expected, despite experiencing lingering material constraints on a critical component.
Overall, it was another very solid quarter for the company, driven by the focused execution and alignment on our Doors That Do More strategy by our dedicated teams around the world. I’m very pleased with the continued progress we made in the second quarter on strategic initiatives, which further strengthen our competitive position. Specifically I’m talking about new plants, new products and new marketing initiatives.
Let’s turn to Slide 5. For those that are new to our story, we developed the Doors That Do More strategy in 2020 as a way to accelerate the growth of the company. The objective of this strategy is to drive outperformance in any macro environment by being the most reliable supplier to our customers, launching differentiated products and becoming the most preferred door brand in our markets.
We believe that by executing the strategy, we can achieve our ambitious 2025 Centennial Plan goals of $4 billion in net sales, 20% adjusted EBITDA margins and sector-leading return on invested capital.
The strategy has three core pillars: deliver consistent and reliable supply, our focus on operational excellence; drive specified demand, our focus on product leadership; win at the point-of-sale, our focus on building the most respected brand in the category. In Q2, we made further progress in all three of these areas.
Let’s turn to Slide 6. Last year, we announced plans to open two new greenfield door plants, one in Fort Mill, South Carolina and one in Stoke-on-Trent, England. Today, I’m happy to report that both plants are online and have started producing and shipping quality doors. The plant in Fort Mill specializes in the assembly of interior doors and is an important to upgrade to the production network for our North American Residential business.
The manufacturing footprint has been designed using our Mvantage principles and the practical use of automation to drive a safer, more efficient and reliable operation. The plant has been strategically located to take advantage of a deep and talented local labor pool, as well as major transportation routes that enhance our access to key markets.
We plan to continue adding equipment and expanding operations in the Fort Mill plant throughout the second half of this year and into 2023 with the objective of making it our most efficient doors than we plant in the U.S. Over in England, our team fully completed transition of production to the new Stoke-on-Trent site in the second quarter.
As you may recall from our previous comments, this plant combines the exterior door assembly operations from five buildings into one new facility with a highly optimized production layout. Moreover, the old buildings were located in an area where local ordinances limited our hours of operation. Our new site is in an area with no such restrictions, which gives us headroom for future growth. I’m proud of what these two plants represent in terms of the first pillar of our strategy, consistent and reliable supply.
We are making our production networks more resilient and flexible while giving us opportunities to achieve production efficiencies that were not possible in our older facilities with less ideal layouts. I’d like to thank and congratulate the many Masonite employees involved in these two successive projects and give special recognition to the U.K. team that transitioned production into the new location without any interruption in service to our customers.
Let’s turn to Slide 7 and talk about driving specified demand. Fiberglass entry doors have been gaining popularity for over a decade because of the energy efficiency, low maintenance, durability and style they offer.
Masonite sells a wide range of fiberglass doors from opening price point up to our M-Pwr Smart Door. And this June, we were excited to add the Masonite Performance Door System backed by a 10-year limited full replacement warranty to our fiberglass product portfolio. This door system features a four-point performance seal, including an Endura self-adjusting sill, adaptive weather stripping, square edges and enhanced corner pads.
It has undergone certified third-party testing and is proven to be 64% better at keeping air and water out than the leading competitor. The system is offered with all Masonite exterior fiberglass doors, including three new Shaker style designs. These new exterior designs, also released in Q2, represent an important addition to one of our most popular product portfolios. Builders and homeowners can now buy exterior doors that match our popular interior Shaker style doors in a complete home package.
The Masonite Performance Door System and the new fiberglass exterior door designs demonstrate our continued commitment to product leadership and will help us drive positive mix in both homebuilders and homeowners that are looking for an upgrade in performance and style. For more information on these new products, I invite you to visit our product pages at masonite.com.
Turning to Slide 8. Winning at the point-of-sale is about building strong brand loyalty through creative down-channel marketing and creating a seamless purchasing experience. Although we have prioritized enhancements in consistent and reliable supply and product innovation in the early phases of our strategic plan journey, our team has been working hard on a number of initiatives related to winning at the point-of-sale as well.
These have included digital marketing campaigns to drive awareness and preference, refreshing in-store displays to aid in product selection, increasing the assortment of products for sale online to meet consumers where they want to buy, developing channel-specific programs to improve product mix and adding the Masonite name to hinges on the millions of pre-hung doors we sell into the market each year to expand visibility of the Masonite brand.
Two case studies that demonstrate the importance of this strategic pillar are the programs we put together to drive barn door and solid core volume growth. In both cases, we began with market research that gave us insights into consumer product preferences where consumers go for inspiration, how they learn about their options and the key factors in their decision to make a purchase. To engage these consumers, our marketing team created digital content targeted at both builders and homeowners.
Simultaneously, we placed physical displays in retail stores, so people can touch and feel the difference between products. Finally, we expanded our online selection to give both pros and DIYers more ways to buy at their convenience. As a result of these initiatives, we have seen tangible mix shift toward these higher value products.
Barn door sales volumes have shown a compound annual growth rate of over 20% since pre-pandemic days and the growth rate of solid core door volumes has been nearly three times the growth rate of interior doors overall, since launching our Sound Decision marketing campaign.
As you can see, implementation of our Doors That Do More strategy is happening across the organization. Many of the projects have required months to bring to light. So I’m thrilled to see us hitting big milestones with these new plants, products, and marketing initiatives in the second quarter of this year. I’m confident that these investments are driving product mix, operational efficiencies, and overall competitive advantage, that will make valuable contributions to our performance in 2023 and beyond. The execution of our strategy is foundational to our ambitious Centennial Plan goals.
With that, I’ll turn the call over to Russ to provide more details on our financials. Russ?
Russell Tiejema
Thanks, Howard, and good morning, everyone.
Turning to Slide 10, I’ll start with an overview of our second quarter financial results. We reported net sales of $762 million, up 15% as compared to the second quarter of 2021. The growth was primarily due to a 19% increase in AUP, which was up year-over-year on price implemented to offset inflation as well as positive product mix.
This increase was partially offset by a 2% decrease due to unfavorable foreign exchange, 1% decrease due to a prior-year divestiture and a 1% decline in volume. The year-over-year volume change was driven by declines in the Europe and Architectural segments, offset by an increase in the North American Residential segment.
Gross profit increased 9% in the quarter to $179 million while gross margin decreased 120 basis points year-over-year to 23.6%, due primarily to the impact of inflation and the volume deleveraging impact on factory and distribution costs in the Europe and Architectural segments.
Selling, general and administration expenses were $90 million, up 10% compared to the same period last year while SG&A as a percentage of sales improved 60 basis points to 11.9%.
Net income was $59 million in the quarter, an increase of $23 million from the prior year, driven primarily by higher gross profit as well as the absence of restructuring charges, asset impairments, and a loss on the disposal of our Czech business in the second quarter of 2021, partially offset by an increase in SG&A and income tax expense.
Diluted earnings per share were $2.58, up 83% versus the $1.41 realized in the second quarter of last year. Adjusted earnings per share were also $2.58, up 16% compared to the $2.23 realized in the second quarter of 2021 which excluded $18 million in charges related to the restructuring and disposal impact I just noted.
Adjusted EBITDA increased nearly 7% to $118 million for the quarter, despite the volume deleveraging in our Europe and Architectural segments. As noted on our first quarter call, we have seen inflation continuing to accelerate. In response, we implemented incremental price actions late in the second quarter. Adjusted EBITDA margin in the second quarter declined year-on-year as expected, down 120 basis points to 15.5%.
On the right hand side of the slide is further detail on our adjusted EBITDA performance, which continues to benefit from year-over-year AUP growth. The impact of material inflation including ocean container and other inbound freight costs reached $68 million in the quarter.
Factory and distribution costs were up approximately $35 million, driven primarily by inflation on labor, outbound freight rates and packaging materials with additional impact coming from volume deleveraging, start-up costs for new plants and increased healthcare costs. SG&A was up $8 million in the quarter with over half of the increase due to a year-on-year variance in accruals for incentive compensation and the remainder coming from investments in people and strategic initiatives.
Let’s turn to Slide 11 for our North American Residential segment results. Net sales increased 23% to $608 million, attributable to AUP growth of 21% and volume growth of 3%. Foreign exchange was a modest offset of negative 1%. While pricing drove much of the AUP increase, sales of higher-value doors including solid core, also delivered favorable mix. The volume increase reflected a continuation of steady demand in the second quarter and our operational team’s ability to service that demand.
Adjusted EBITDA in the North American Residential segment was $125 million in the second quarter, up 25% from the same period last year with an adjusted EBITDA margin of 20.6%, up 30 basis points on solid execution. The North American Residential team has built great momentum in the first half of the year, both operationally and on executing on strategic growth initiatives. Their focus now turns to balancing appropriate actions to respond to uncertain market conditions with thoughtful investments to support top line growth and continued margin expansion in the future.
Turning to Slide 12 in our Europe segment. Net sales of $74 million were down 16% year-on-year. However, net sales were roughly flat excluding the impact of unfavorable foreign exchange and the divestiture of our business in the Czech Republic completed in June of last year. Strong AUP growth of 16% was offset by 16% lower volume due primarily to declines in our exterior business servicing the renovation market, which has been impacted by continued weakness in consumer confidence.
Adjusted EBITDA was $9 million in the second quarter, down 48% year-over-year. Adjusted EBITDA margin was 11.6%, down 730 basis points due largely to volume deleveraging and factory relocation costs. Despite the current macro headwinds impacting the U.K., our view remains constructive for that market given the combination of an aged housing stock and the shortage of new housing construction.
Our Europe team has executed initiatives to deliver both improved productivity and create a more robust platform to support long-term growth. The seamless transition to our new exterior door plan in Stoke-on-Trent is a great example. Looking ahead, the team’s full attention is on managing cost in line with current demand levels.
Moving to Slide 13 and the Architectural segment. Net sales of $75 million were roughly flat in the quarter as the 13% increase in AUP was offset by a 13% decline in volume. Adjusted EBITDA improved sequentially by $3 million from the first quarter.
Our Architectural team was able to build on the progress made in Q1 in the areas of staffing and training on new equipment and systems to deliver the sequential improvement, but their efforts to grow volume were hampered by material constraints that proved more acute than expected. As with other manufacturers that produce wood veneer doors for non-residential markets, we use a fiberboard product called crossband as a backing for the door facings.
Availability of this component has been limited this year in the sizes and configuration we use, causing our team to expand our sourcing footprint. This requires a rigorous and time-consuming qualification process, particularly where fire testing is required to achieve appropriate certifications. Our sourcing and R&D teams have recently qualified new suppliers and we anticipate that availability will improve as we exit the third quarter.
Turning to Slide 14, we’ll cover liquidity and cash flow performance. Our balance sheet remains very strong. At quarter end, our total available liquidity was $482 million, inclusive of unrestricted cash, our undrawn ABL facility, and an accounts receivable sales program. Net debt was $635 million, resulting in a trailing 12-month net debt-to-adjusted EBITDA leverage ratio of 1.4 times.
Cash flow from operations was $34 million through the end of the second quarter as compared to $33 million through the second quarter of 2021. Capital expenditures were approximately $40 million in the first six months of 2022, up from $30 million in the prior year. As Howard mentioned, during the second quarter, Masonite completed the accelerated share repurchase agreement announced in Q1.
In total, the $100 million ASR transaction resulted in the retirement of nearly 1.2 million common shares at a volume weighted average price of $85.63 per share. Year-to-date share repurchases totaled $140 million or approximately 1.6 million shares through the end of the second quarter. Based on our share repurchase activity to-date, we expect an average diluted share count of approximately 23 million for the full year.
Turning to Slide 15. Based on our strong year-to-date performance and further price/cost actions that were implemented in the second quarter, we remain confident in our ability to meet or exceed our net sales and adjusted EBITDA outlook for 2022. As we discussed on last quarter’s earnings call, a number of macro cross-currents are influencing our end markets and cloud visibility into demand in the second half of the year. This backdrop of uncertainty remains unchanged.
On one hand, we continue to drive favorable mix with marketing initiatives that target consumers seeking higher value door products. Increased levels of home equity also provide support for continued renovation activity and we have seen this play out in the form of stable point-of-sale rates in our U.S. retail channel in the second quarter.
However balancing these tailwinds, higher mortgage rates and persistent inflation present affordability headwinds in new housing. While the need for additional housing units in our primary end markets suggest long-term growth prospects remain intact, we anticipate that U.S. housing starts will continue to soften through year end.
Accounting for these factors and considering the potential for channel destocking in response, we expect volumes will be down in the second half, both in North American Residential and on a consolidated basis. Foreign exchange headwinds have also increased further, particularly for our Europe segment on continued strengthening of the U.S. dollar.
Inflation in the second half is now expected to be higher than our prior assumptions, particularly the third quarter and due in part to the timing of higher cost material and logistics flowing through inventory. However, price/cost actions we have taken will enable us to fully cover this inflation.
Due to our current view on the anticipated geographic mix of income in 2022, we now expect a higher full-year tax rate of approximately 24% with cash taxes in the range of $75 million to $85 million. Reflecting the impact of higher cash taxes and incremental inflation on our working capital balances, we now anticipate full-year free cash flow of between $120 million to $150 million. And finally, accounting for our higher tax rate and lower share count, we now expect our full-year adjusted earnings per share to be in the range of $9.60 and $10.60.
In closing and consistent with our view last quarter, we believe our ability to exceed this outlook will largely be a function of industry volume at our North American Residential segment. Our operations team stands ready to service demand and our disciplined approach to price/cost positions us to deliver year-over-year margin growth for the full year 2022.
With that, I’ll turn the call back to Howard for closing comments.
Howard Heckes
Thanks, Russ.
In Q2, our team delivered another quarter of year-over-year net sales and adjusted EBITDA growth. We also achieved key strategic milestones, including the opening of two new plants to modernize our production network and the launch of several new products, featuring enhanced performance and style.
I believe this quarter provides a great example of the results we can achieve with tight organizational alignment around a clear strategy and strong execution of that strategy. As Russ noted, we remain confident in our ability to meet or exceed our outlook for full-year 2022 net sales and adjusted EBITDA, based on our performance year-to-date and factoring in a conservative view of the second half.
As always, our intention is to continue to exploit the opportunities and mitigate the risks in order to realize the full upside potential in this outlook. Our Centennial Plan remains our true north and I am confident that our team will continue to successfully navigate through macroeconomic challenges to outperform in any environment and to achieve our long-term objectives of sustained top line growth and margin expansion. We are confident we have the right people, the right strategy and the right assets in place to successfully execute our plans and we are grateful to all of our employees, customers, partners and investors that continue to support us.
Now, I’d like to open the call to your questions. Operator?
Question-and-Answer Session
Operator
Thank you, Mr. Heckes. [Operator Instructions] Our first question is from Mike Rehaut with JPMorgan. Please proceed.
Mike Rehaut
Thanks. Good morning, everyone. Thanks for taking my question. It’s Mike Rehaut. Just – appreciate all the color and congrats on the quarter. Wanted to just be clear, I guess, to make sure I understand with regard to your price/cost performance so far and how you’re thinking about the back half, it sounds like you covered price/cost or you covered cost inflation through price in the second quarter and you expect to continue to do so if I heard right in 3Q and 4Q. I just wanted to make sure that was both on a dollar basis and on a margin basis or just on a dollar basis? How are you thinking about that?
Russell Tiejema
Hi, Mike. It’s Russ. Thanks for the question. Yes, we are expecting to cover both on a dollar and margin basis price/cost.
Mike Rehaut
Great, great. And then also, you gave some granularity around back half volumes, I believe, expected to be down. Just wanted to also kind of unpack that a little bit. Given how your price mix has kind of trended in the first half of the year, it would seem like unless there is a significant drop-off in your year-over-year price gains, particularly for North America in the back half, we’re kind of modeling and I know you don’t want to get that granular, but just obviously with what you did in the first half around 18% contribution on average, 18%, 19% actually, if you’re continuing in the mid-teens at least.
I know the fourth quarter is a tougher comp, it would suggest that volumes might have to be down mid-single digits or greater. It didn’t sound like that’s necessarily what you’re expecting with the volume growth. So any more granularity about how you’re thinking about volumes and price in North America in the back half?
Russell Tiejema
Yes, Mike. It’s Russ. Let me unpack that a little bit for you. And first of all, I appreciate the non-regarding our first half performance. I don’t think we can understate how pleased we are with the team’s ability to deliver both strong AUP and volume growth in the North American residential business in the first half. All right.
So then what does that mean for the second half? If you look at our guidance range and you walk between say the mid and the high end of that guide, it would imply that our second half net sales would be up, call it, mid-single digits. And as we did remark during the prepared remarks, we are expecting volume to be down second half, but we are expecting strong AUP performance to continue through the year, based on the price/cost actions we’ve implemented, both the price increases taken in January and the secondary actions that we announced in late June. So what that all means is that our guide allows for volumes to be down double-digits.
Now, that would be – volume declines would largely be in the residential markets. So we think that there could be the opportunity that market demand itself could be down mid-single digits. And then, because I noted during my prepared remarks around the outlook, there is also a chance that we’ll see some destocking in the wholesale channel in response to housing starts starting to soften. So again, put that all together and it would suggest that the guide can absorb a double-digit volume decline.
Now, we don’t necessarily expect that that could play out, but frankly, just given the turbulent backdrop that we’re managing into, we thought it was prudent to be conservative and that’s how we think about the moving pieces in the second half.
Howard Heckes
Yes, so this is Howard, Mike. I think that’s the important part, what Russ said there at the end is that’s not necessarily what we expect to see. But our strong first half start allowed us to be conservative with our continued outlook where we really believe we can meet or exceed that. There are a number of issues, obviously, happening in the market and the guide allows demand to fall pretty significantly and for us to still be comfortably without it.
Mike Rehaut
Just to clarify on that and I apologize for kind of my second follow-up here, but I think it’s really important. There are other building products company this past earning season that have highlighted that they’ve already begun to see destocking and-or market softness at the point of sale. Through July, is – your comments still kind of point more to caution based around what you’ve heard, not necessarily and this is what I’m trying to clarify what you’ve seen.
So in other words, have you begun to see any signs of destocking and/or market softness that is driving that volume outlook or is this just more or just a little bit or is that predominantly just based off of macro concerns and what you’ve heard, but not necessarily what you’ve seen yet?
Howard Heckes
I’d say that July, Mike, was a little bit softer than the second quarter. So we saw maybe some signs of destocking, but not anywhere near to the level that the guide allows in the back half.
Mike Rehaut
Great. Perfect. Thanks so much.
Howard Heckes
Thanks, Mike.
Russell Tiejema
You’re welcome. Thanks, Mike.
Operator
Our next question is from Mike Dahl with RBC Capital Markets. Please proceed.
Mike Dahl
Hi. Thanks for taking my questions and for this helpful color in response to mix. A couple of follow-ups just in terms of the inflationary dynamic, can you help us better understand what impacted second quarter, so the rate of inflation that impacted the second quarter? What your new expectations are for the full year? And then you said, second half in particular is ARPU of 3Q seeing the – so again, maybe just quantify what that means in terms of percentage of equation would be – would be great.
Russell Tiejema
Yes. Hi, Mike. It’s Russ. I’ll take that one. We’ve seen inflationary pressures really persist across the board. Now, we’ve done a lot on the productivity side to help get in front of some of the labor cost inflation, but material inflation continues to be a headwind for us, material and logistics in particular and they’ve built a little bit even beyond our expectations when we laid out our guidance for material last quarter, we’re seeing headwinds in wood materials, ocean freight as I mentioned.
Now, we are seeing early signs that the materials inflation has plateaued and we see the opportunity for material that we’re placing orders as we get later into Q3 and Q4 may begin to moderate a little bit.
But frankly, we don’t expect that to really provide any P&L to – impact or benefit to any degree until we get very late into this year or even next year and that’s just due to the fact that we’re typically consuming material and production in the current environment several months after we purchased it. Elongated supply chains are creating some of that. That’s why I made the comment during my prepared remark about higher cost material flowing through inventory and into the P&Ls. We’re now consuming it for produced product.
Now all of that said, what that means is that our inflation outlook is pushed a little bit out to the right. We see some continued inflation peaking up into Q3 before it stabilizes and drops off in Q4. That leaves our full year outlook right now whereas on the last quarter call we said in the range of 20% for the year is probably now in the low to mid-20s for full year 2022.
Mike Dahl
That’s very helpful. And then as a follow-up, it’s exciting in terms of the two new plants getting operational and ramping up. Presumably, there is – while the transition seem to have gone smoothly, there is some sort of ramp costs associated with these. Maybe you can help us understand kind of where these plants are at today in terms of profitability or what those headwinds have represented relative to the total company. And then, the path or a timeline for getting up to company average margin and presumably based on what you’ve said about these would eventually be more profitable. So maybe any color you have on an even longer-term goal for those plants in terms of profitability?
Howard Heckes
Yes, sure, Mike. This is Howard. We are proud of the efforts to get those plants online in this environment. It wasn’t easy, certainly. If you look at both of them, the Stoke plants, where they’re absolutely worse with start-up expenses that impacted of the P&L for the U.K. business – European segment in the quarter. In fact, if you normalize sort of those costs as well as some of the spike in energy, that business would have been more in the 13% range which we’re pretty proud of in a pretty difficult environment on the European segment.
So that’s going to – the efficiency of that plant is going to be significant for us, because as we’ve mentioned a number of times and in fact as we said in the prepared remarks, we took five different facilities – buildings on one campus and then combined them into one. So we – absolutely there is learning curves and as you said some start-up expenses, but we would expect to see some benefit to the P&L due to efficiency with Stoke.
Fort Mill is interesting for us because this will be, we believe, our most efficient door assembly plant because we’re really using targeted automation in areas where we had our people in the past in jobs that they knew weren’t highly desirable, we’ve replaced with simple, practical innovation that is in a business plant recently after it started making doors and it’s terrific.
As I said, it’s not – it doesn’t blow your mind with automation, but it’s practical and it’s going to create a very safe, reliable and efficient operation, we believe, the most efficient in the network. So both will be favorable to the P&L. There are start-up costs and efficiencies and learning curves that we go through. In fact, when I was in Fort Mill recently, all kinds of CI engineers and automation engineers running around the factory, so it’s certainly not our most efficient plant today, but it will be soon, and we’re excited for that.
Russell Tiejema
Hi, Mike. It’s Russ. I might just add one other quick point, and it’s more specific to Fort Mill. The placement of that plant was pretty thoughtful geographically because we wanted to be in a position to most – position to most efficiently serve some of our highest growth markets in the Southeast and the Mid-Atlantic. And the placement of that plant outside the Charlotte Metro in addition to the labor pool benefits that Howard mentioned, that also positions us very well to more cost efficiently service those markets, with more efficient freight lanes.
So there are probably some distribution savings that we see going forward. It’s a matter of really bringing that plants up to full ramp and continuing to invest in some of the automation that makes it even more productive when it’s running at full rate.
Mike Dahl
That’s great. Thanks, Russ. Thanks, Howard.
Howard Heckes
Thanks, Mike.
Operator
Our next question is from Josh Chan with Baird. Please proceed.
Josh Chan
Hi, good morning and thanks for taking my questions.
Russell Tiejema
Hi, Josh.
Josh Chan
Hi, good morning. So my first question, I guess, on price versus cost. I know you guys said that you expect to be positive all year, but based on your comments and the timing of pricing, was Q2 sort of the narrow-less positive gap between the two or would that be Q3?
Howard Heckes
And I think likely to be Q3 now. As Russ said, Josh, it’s interesting because what we’re using today, we bought, in some cases, several months ago. We order and then it gets on a boat, it arrives and so we continue to see inflation actually growing on our income statement because of the timing of when we ordered the product.
And that’s the sort of work through the network. So Q3, I think, we’re going to continue to see escalation. And by the way, our philosophy to remain price/cost favorable is alive and well and it’s why we took another action in June because inflation, as we said, is now, we think, in the low to mid-20s where going into the year, we thought it was going to be in the low to mid-teens. And so, it’s our obligation to address that with other actions, which we did. So I think Q3 will probably be a little tighter and then, it should open up a bit in Q4.
Josh Chan
Okay. Yes, that’s great, that’s helpful. And then I guess longer term on margins, I know you have a margin expansion target out there. I know you can’t comment on ’23 too much quantitatively, but could you just talk about sort of the pluses and minuses in terms of margins looking into ’23 and how you’re kind of qualitatively thinking about the trajectory there?
Howard Heckes
Yes, so we won’t – you’re right. We’re not going to talk much about ’23 on this call, we’ll get to that in October. But we talk a lot about mix and that’s going to continue to be important and we continue to drive favorable mix. So, a big important part of our Doors That Do More strategy is making life and living better by designing and producing doors that address these basic human needs of comfort and security and style and convenience.
And that means higher prices and higher value. And so, mix is going to be important. This price/cost favorability philosophy, which I think we’ve proven over the last several years, a pretty disciplined approach there will continue to drive incremental mix. Of course, we’ve – I’m sorry, incremental margin.
Of course, we had some problems in the Architectural segment over the last 12 months to 18 months and that’s been a pretty significant drag on consolidated margins. And so, that’s going to help. So we still really believe that these 20% adjusted EBITDA margin by 2025 are realistic. Are they ambitious? Sure. Are they aggressive? Absolutely. But it’s our target, it’s really our true north as we said in the script and that’s what we’re shooting for, Josh.
Josh Chan
Thanks for the color, Howard, and good luck for the rest of the year.
Howard Heckes
Appreciate it.
Operator
Our next question is from Trey Grooms with Stephens. Please proceed.
Noah Merkousko
Morning. This is actually Noah Merkousko on for Trey.
Howard Heckes
Hi, Noah.
Noah Merkousko
Hi. So first I wanted to dig in a little bit more on the destocking. It sounds like you’re not seeing it much anymore, but if I heard correctly, the guide allows for volumes to be down double-digits and that’s mid-single digits for end market demand. I’m guessing that implies the rest would be the potential in destocking? So if you could clarify that, that’d be will be helpful. And if that were to occur, do you think the necessary destocking that would occur in the channel would be completely flushed out by the end of the year or could that be a headwind heading into ’23?
Chris Ball
Yes, this is Chris here. Let me take that, especially from a North America perspective. So if you hear the discussion around this wholesale destocking and we really see retail as being a bit more stable. That is occurring as Howard said in July, but if you step back and look at what’s driving it, there is a destocking phenomenon in the order rates that are coming in, but we also have had really strong operational performance.
If you look at what happened in the first quarter and how we highlighted that progress and you now see that volume growth that we’ve seen in the second quarter, we really see that as also one of these key drivers as we’re moving forward throughout the quarter. So I’d really say that both of those factors are really what are driving the overall order book and also how we’re making sure that we’re getting the right service levels and delivering back on the Doors That Do More strategy around delivering reliable supply in the market.
Noah Merkousko
All right. That’s helpful. Thank you. And then for my follow-up, I wanted to talk a little bit more about the mix benefit you’re seeing, just given the strategy of Doors That Do More. I don’t know if you can quantify how much that helped APU in the quarter, but with this weakening macro backdrop, maybe you could talk about how your tactics might be changing there as we look forward and if you expect that to continue to accelerate as you’re making these investments in Doors That Do More.
Russell Tiejema
Hi, Noah. It’s Russ. Let me take the first part and then Howard will, I’m sure, want to comment on the second part of your question. If you look at our AUP performance in the quarter, it was driven principally by price, but we did see a mix tailwind as we noted during our prepared remarks, really across the residential businesses.
We saw circa a couple points were the favorable mix in the North American Residential business. A little bit of unfavorable mix in Architectural just because they’ve seen a greater mix of stock doors versus some of the higher AUP project work. But in the residential part of the business, product mix has been a favorable tailwind for us, worth a couple of points in the second quarter.
Howard Heckes
Yes. The Architectural bit that Russ just talked about, we’ve talked about that cross-band and the fire ratings and that’s an important part of that mix, but the cross-band, obviously, hurt us from a volume perspective and from a mix perspective, because some of the higher value doors were more difficult to make. As far as how we change our tactics, this mix is important. We continue to have consumers tell us that they expect the Doors That Do More. Everything around the home’s evolved and doors should evolve too.
And so our marketing and I highlighted in the prepared remarks a number of things we’re doing from a marketing perspective. What I love about it is, none of this is terribly expensive. It’s very efficient. So when you think about digital marketing campaigns that are very targeted at certain consumer segments, pretty reasonable to get after that.
When we think about in-store displays, there’s some capital involved in in-store displays, but again pretty important for people to be able to touch and feel and aid in their product selection. Online, adding products online through our partners that have online sites, again, a very inexpensive, but meets consumers where they want to buy. And then, simple thing like adding the Masonite name to our hinges, people look at that and say, well, really?
But what we learned was people love their doors and we want them to know they’re Masonite doors. And so, these things are all, I call them scrappy marketing programs, that are pretty inexpensive and we are seeing now, as Russ said, favorable mix and – we talk about solid core doors, three times the growth rate of solid core to our interior door rates, that has a meaningful impact on our P&L. And so, when we can have 2 points or a few points of mix growth and this is increasing quarter-to-quarter due to some of these campaigns we’re talking about, I think it’s a very successful strategy.
Noah Merkousko
Yes. And it sounds like you’re having some early wins there. Well, I appreciate the answers and I’ll leave it there.
Howard Heckes
Thanks, Trey.
Operator
Our next question is from Steven Ramsey with Thompson Research Group. Please proceed.
Steven Ramsey
Hi, good morning. Was hoping you could add some more color around retail stocking being more stable. You talked about solid POS there, I believe, in the second quarter. Can you maybe compare – go into a little more detail on retail for Q2 and the second half and how it compares to the wholesale activities?
Chris Ball
Yes. Steven, this is Chris again. So if you really look at our overall business, I mean, we have both the new construction portion of the business as well as the repair/remodel, and it’s about 50-50 between the two businesses. So as you look at the overall environment right now, there’s been a slowdown from a new construction starts endpoint and I talked a little bit about that wholesale stocking.
On the retail side, it’s a bit more – much more focused on the remodel side. That’s more steady in the outlook which you see in the marketplace has that more healthy, at least, in the near term. So kind of between the tools and we’re seeing that play out, both as we exited Q2 and as we’ve gotten into Q3 and really when you look at both of those trends, that’s really what reflects the overall outlook and also what we can allow here as we predicted the back half of unit growth as well as from a AUP growth.
Steven Ramsey
Okay, helpful. And then on North America Residential, the more uncertain outlook and the balancing act that you said for operating the business in this type of environment, can you talk more about what that means and if you’ve taken any actions already to start lowering costs or tightening the belt in preparation for slowing.
Russell Tiejema
Hi, Steven. It’s Russ. Let me take that one. In the current environment, we’ve not been forced to react with any kind of cost management actions aggressively in the North American Residential business. Now, that doesn’t mean we’re not prepared to do that though. Several years ago, we developed pretty comprehensive playbooks for each of our segments on how we would respond to changes in volume that would become more durable in nature, including downsides.
The business segments update those playbooks on an annual basis as they rework their plans for the year ahead. That work is underway right now, but there are a number of levers that we have from a cost management perspective to the extent they’re needed. I guess, I’d first start though by reminding everyone that we’ve got a pretty highly variable cost structure in our cost of goods sold in particular. Over 50% of our COGS is material. Another circa 30% is direct labor and distribution which you can typically manage pretty closely with demand.
And then, it’s just the balance of overhead that would need to be managed more carefully if we were to see a significant downturn in volume that we think is going to be more durable in nature. But at the end of the day, we’ve got several levers that we can pull in managing costs.
We’re really excited about what some of the new investments that we’ve made in our manufacturing network allow us to do, not only the capacity additions we’ve made over the last couple of years in Mexico, but now in the new plant in Fort Mill, South Carolina because it gives us a naturally more efficient and optimized footprint to leverage the extent that we need to re-rack our capacity in the event that we saw more durable and long-term downturn.
Steven Ramsey
Great. Thank you.
Operator
Our next question is from Jay McCanless with Wedbush Securities. Please proceed.
Jay McCanless
Hi, good morning. Thanks for taking my questions. First one I had, I think, you guys have already answered this, but if you look at the backlog of what’s heading out, is there still that favorable mix in terms of getting higher prices in the back half of the year that you saw in the second quarter?
Howard Heckes
We would expect so, Jay, yes.
Jay McCanless
Okay. And then just on Europe for a minute, I’m assuming that it’s – you talked about U.K. consumer confidence being weaker. Have you seen any improvement in that in July and August or is it still pretty rough on that side of the pond?
Howard Heckes
Yes, no, pretty – it’s been pretty consistent, Jay, in July, certainly. We do think that the long-term macros are still really good there. Housing is underbuilt and we certainly see long-term upside in that market, but we’re expecting some choppiness through the balance of ’22 consumer confidence there is weak and volumes have been soft. But the team is taking appropriate actions. They’re doing what they need to do on the price/cost basis and again, we feel really good about that business. A low-teens margins in this environment, we think, is pretty good. I’m proud of our team over there for that delivery.
Jay McCanless
Okay. Thanks for taking the questions.
Howard Heckes
Thanks, Jay.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Howard for closing comments.
Howard Heckes
Thank you, Sherry, and thank you all for joining us today. We appreciate your interest and continued support and this concludes our call. Sherry, please provide the replay instructions. Thanks.
Operator
Thank you for joining Masonite’s second quarter 2022 earnings conference call. This conference has been recorded. The replay may be accessed until August 23. To access the replay, please dial 877-660-6853 from the U.S. or 201-612-7415 outside the U.S., enter conference ID 13730458. Thank you. You now may disconnect.
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